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Bubbles and Crises

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  • Allen, Franklin
  • Gale, Douglas

Abstract

In recent financial crises a bubble, in which asset prices rise, is followed by a collapse and widespread default. Bubbles are caused by agency relationships in the banking sector. Investors use money borrowed from banks to invest in risky assets, which are relatively attractive because investors can avoid losses in low payoff states by defaulting on the loan. This risk shifting leads investors to bid up the asset prices. Risk can originate in both the real and financial sectors. Financial fragility occurs when positive credit expansion is insufficient to prevent a crisis.

Suggested Citation

  • Allen, Franklin & Gale, Douglas, 2000. "Bubbles and Crises," Economic Journal, Royal Economic Society, vol. 110(460), pages 236-255, January.
  • Handle: RePEc:ecj:econjl:v:110:y:2000:i:460:p:236-55
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    References listed on IDEAS

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